Puzzle Finance Blog

Hold or fold: the end-of-mortgage dilemma

Paying off a home loan is certainly cause for celebration – but is it worth holding on to the loan facility rather than discharging the mortgage? Sure, you finally hold the title deeds, but in doing so are you letting go of a source of “emergency funds” into which you may need to dip?

Mortgage broker Owun Taylor of Mortgage Choice says most homeowners who make a big effort to pay off their loan early are so thrilled that they discharge the mortgage without thinking ahead.

He cites two clients who closed their home loan facilities but now regret it thanks to changed circumstances.

One had split his mortgage into fixed and variable rate components. But on inheriting a large sum of money, he paid the variable part of the loan and closed it. Now he wants to renovate the family home and, rather than dipping into an existing loan, he has to set up a new one.

“He was so full of joy at seeing what he’d paid off, but he’s lost the ability to redraw [equity in the home],” says Taylor.

“[Discharging the loan] is a much older way of looking at this – now he’s got to go back to the lender, provide payslips for him and his wife, and put in a full application to go back and borrow the money he already had on hand.”

The time spent doing this has also lost him a window of opportunity. “He had a builder ready, but because it will take four weeks until he can get the cash, he’s lost the slot,” says Taylor. “He’s kicking himself.”

The other client – who also had a variable/fixed loan split – is looking to buy a larger family home and needs to come up with a $130,000 deposit in a few weekends when he bids at auction.

“He came into some money, and rather than just putting it into the variable loan [to be available for redraw], he asked the lender to credit it to the loan and reduce the loan size,” says Taylor.

The variable component of the loan was dramatically reduced, meaning he can’t redraw the $130,000 deposit if he is the successful bidder on a new $1.3 million home.

“He didn’t think about the bigger picture. He’s asset-rich but cash-poor, so now is having to refinance that property [to come up with a deposit],” says Taylor.

Stamp duty a consideration

Smartline Personal Mortgage Advisers’ Michael Daniels agrees there can be benefits in keeping a loan facility open after it has been paid down to zero.

“Ultimately, however, the benefits lie in the convenience and savings,” says Daniels, Smartline state manager for NSW and the ACT.

“For example, while redraw facilities often allow you to take money out of your loan account without having to go through the entire credit approval process again, some redraws have time limits, others have maximum single-draw limits and others cap the amount that can be redrawn without a credit assessment.”

He points out that the other flaw in paying down a loan and then needing to organise another one for a similar amount is mortgage stamp duty. “This duty is no longer levied on the purchase of residential dwellings, but it’s charged at about $4 per $1000 if you borrow against your dwelling for other purposes, such as buying shares or paying for a holiday.

“If you paid mortgage stamp duty in the past, it will be based on the original size of the loan. If you borrowed $400,000, for example, you will have a stamp duty limit within that amount.

“If your redraw stays within this limit, you don’t have to pay duty again – for any redraw purpose. But if you discharge your mortgage, you lose your stamp duty limit and could have to pay a fee if you re-borrow in the future.”

Discipline Required

Financial adviser Justin Hooper, managing director of Sentinel Wealth, advises caution if you’re able to redraw on your mortgage. “If you are not disciplined, you could end up using the money when you shouldn’t. If that’s the case, do yourself a favour by getting rid of the facility to make it more difficult.”

If the only time you intend making a redraw is a genuine emergency – to cover medical bills or overseas flights in the event of difficulties with family overseas, for example – being able to access the equity in your home is a cheap source of funds. And it’s preferable to having to sell investments within a fixed time frame.

For older mortgage borrowers, though, it can be more difficult, even if their balance is close to zero, says AMP chief operating officer Rob Slocombe. Not only can they redraw less towards the end of their loan, often the only option is setting up a new loan.

Given their age, the lender will need updated information on their financials, as well as an “exit strategy” outlining how they will repay the loan (even if they never intend to use it).

Some lenders cite “conversion fees” of about $350 to switch from older loans to newer ones with slightly extended loan terms, and there may be redraw restrictions.

In essence, though, what many are looking for is access to a facility they may never use – in other words, a cheap source of “just in case” emergency money.

So for those close to the end of the term of their original mortgage, the only choice seems to be to discharge the loan (where costs include solicitors’ fees ranging from $300 to $400) and set up a line of credit secured on their property.

For older borrowers, say in their fifties, this might involve a 10-year term. But the costs of setting this up can be much the same as mortgage start-up costs – around $600. An expensive way to set up access to money you may never need.

Posted by Debra Cleveland -- Australian Financial Review on 21st June, 2014 | Comments | Trackbacks

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